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10 minutes with…Paul Reed

Aberdeen recently launched an onshore version of its Luxemburg-domiciled high-yield bond fund, with veteran manager Paul Reed remaining bullish on his end of credit markets.

Reed celebrates 20 years at Aberdeen in 2011, having joined in 1991 from Merchant Navy Officers Pension Fund.

During this time, he built up the Aberdeen fixed-interest portfolio into a £1bn flagship but it was among the funds sold to New Star in 2003 as the firm looked to restructure its balance sheet and repay debt.

Reed remained at the firm in charge of the offshore high-yield vehicle and feels this part of the debt market is still attractive relative to gilts and investment grade, despite a rally over the last two years.

“The high-yield market has remained resilient despite all the external shocks, from the PIIGS to North Africa and oil price spikes,” he says. “This is largely down to ongoing positive corporate results from across Europe, with default rates expected to stay low this year and next.”

He predicts interest rates will also stay depressed and says high-yield bonds will be attractive to investors seeking income. His own fund is targeting a yield of around 8 per cent to 8.5 per cent.

This has meant increased flows into high yield as investors tire of poor returns from investment-grade, with Europe following America’s surge into this sector.
“We anticipate another positive year for the sector in 2011 with high income supported by modest capital appreciation,” says Reed.

“Investors will not enjoy the outsized gains of the last two years but the asset class remains a good source of income.”

He says gilts now have little to offer and investment-grade credit spreads have tightened considerably, whereas demand continues to exceed supply in high yield on the evidence of recent new issues.

Reed says: “Defaults should remain low, supported by improving trends in company results, despite the weak macroeconomic backdrop. A bottom-up process focused on rigorous, in-house research will be key to driving total returns.”

As with the equity desks at Aberdeen, Reed’s team focuses on analysing company balance sheets and business models rather than reading sell-side or research from rating agencies.

He says many of the companies the team has seen over recent months were able to remain profitable during the downturn and are now reporting improving earnings.
He predicts a reasonable pipeline of high-yield issuance this year, albeit not up to the record levels seen in 2010.

“High-yield bonds have bounced back strongly after being heavily oversold during the financial crisis,” says the manager.

“Back in 2008 and early 2009, an irrational fear of high yield (and all risk assets) led to spreads widening to 1,300 basis points over government bonds. Today, spreads are trading around 540 basis points and fundamentals are back in focus.”

Another key facet of high yield – particularly in current conditions – is its relative immunity from inflation, with most paper of short duration.

In contrast to longer-dated investment-grade credit and government debt, this means the bonds are less affected by rising prices and interest rates.

Reed says high yield is broadly correlated with equity markets, which tend to outperform in periods of modest inflation.

On other prevailing macro threats, he is not overly concerned on oil prices and feels markets will stay on track as long as reasonable global economic growth continues.

On his portfolio, Reed has found value in various under-researched parts of the market, owning payment-in-kind bonds, for example, which have no coupon and pay interest in capital rather than cash.

He is also positive on several financials, including senior bonds in Irish banks and Lloyds, expecting them to perform well in 2011.

“We have sold off many of our positions as they have done their work, with yields coming down almost to investment-grade levels from 20 per cent just a few years ago,” says Reed.

“The new issue market is continuing to develop and we take up around one-third of these, leaving bonds where yields are either too low or that are simply unacceptable as debt.”

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